Where Spain Is Worse Than Greece

By most measures, Greece’s economy is in worse shape than Spain’s. Greece has been largely shut off from financial markets for more than two years; yields on its bonds are still sky high. Gross domestic product has fallen nearly 20% over the previous three years. Spain can still borrow from private investors, and its GDP has fallen around 5% during the crisis.

But if you take forecasts from the European Commission seriously, Greece enjoys one formidable advantage over Spain: Its economy is running well below capacity, while the Spanish economy, despite an unemployment rate around 25%, is operating relatively close to full steam.

Why is that an advantage? According to the commission, it means that the Greek unemployment rate should fall sharply if the economy starts to recover again, without causing inflation. Spain faces a much more difficult situation. If the structure of its labor market doesn’t change, the commission’s analysis suggests that a nascent economic recovery in Spain could be hampered by labor shortages that would spark wage inflation.

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Seems like a strange thing to believe for a country with 25% of its workforce sitting idle. How can this be?

The reason is the commission’s view of the Spanish labor market. During the previous decade, the Spanish unemployment rate dropped sharply as millions of Spaniards found work in the booming Spanish real estate sector.

But the bubble has burst, probably for good. This means, according to the commission’s analysis, that millions of Spaniards need to be retrained to do non-real-estate-bubble-related jobs. In the meantime, their labor won’t be available to do the new jobs that will drive Spanish growth in the future.

Greece faces similar problems, but they are less serious, according to the commission’s analysis. Yes, the “government-borrows-money-and funds-consumption” model of growth won’t be available to Greece anymore. But it didn’t endure the same private-sector credit bubble that hit Spain during the previous decade.

The differences between Greece and Spain can be seen in several economic metrics published by the commission. There is the output gap, or the difference between actual GDP and potential GDP (as a percentage of potential GDP). The figure is a whopping 13% for Greece but just 4.6% for Spain.

Then take a look at the commission’s estimates of the so-called non-accelerating wage rate of unemployment (NAWRU) in Greece and Spain. This is the unemployment rate below which the commission believes the inflation rate starts to rise. It’s also known as the “natural rate” of unemployment. The natural unemployment rate for Greece is around 14.8%; it is 21.5% for Spain. This despite unemployment rates around 25% in both countries.

These numbers speak to the depth of the structural transformation that the commission believes Spain must endure before it can return to sustainable, non-inflationary growth.

Of course, neither the “natural” unemployment rate nor the output gap are directly observable figures. They are estimates made by economists to help central bankers and finance ministry officials figure out whether economies are close to becoming inflationary. So maybe the commission’s estimates are incorrect.

In fact, there is considerable disagreement over the commission’s view of the U.S. economy: It sees the natural U.S. unemployment rate at 7.8%. Not even the most hawkish members of the Federal Reserve’s Board of Governors believe the natural rate is much over 6%.

The problem is that European policymakers are now relying on these estimates more than ever before to draft national budgets. They are giving more weight to the “structural balance” – that’s the actual government balance accounting for the size of the output gap, the “natural unemployment rate” and the general strength of the economy.

Spain’s structural budget deficit is somewhat smaller than its actual deficit (6.3% of GDP vs. 8%), because of the country’s weak economy. But most of the deficit is still “structural,” according to the commission, a disturbing thought in a country where 25% of the workforce is unemployed.

And because the euro zone’s new “Fiscal Pact” requires countries to bring their structural deficits under 0.5% of GDP, Spain still has a lot of government austerity to endure before the cutting is done.

Comments (5 of 7)

I have just returned from a visit to Spain (the east coast). Talking to a number of small business owners they tell me either that business has never been better or that it is difficult but not impossible. There are however changes. Cash transactions are almost universal. When will politicians learn that 20% VAT is far to high.
Restaurants that I have known for years now refuse credit cards. Many people work for cash with no employment contract. They are probably considered unemployed. The attitude is that the government and banks got us into this mess let them find a way out, in the meantime we will try and defeat their taxes at every turn

11:13 pm November 13, 2012

money wrote:

as for GDP reduction... that will be read at -7 for the THIRD QTR this year, as for the EU commission, something says their credibility is now a GOING CONCERN statement !!!!... convinent denial is a sociacopathlogical behavour in order to maintain its place and reason for its own existence..... sad,sad, sad,..... the reason for the new homes was for folks to live in them and enjoy them, provide work and incentive to build them, and yes... pay debt service when due..... not a stacked topside benchtrade arbitrage hedge off of the mass's....europe..of all places...knows what happens when the CROWD gets unhappy..austerity gone bust !!!!!

5:44 am November 13, 2012

Fernando wrote:

Watch this.
A brave, fact based marketing campaign about Spanish crisis, excuse me: opportunity. I just wish anglosaxon press would apply "a drop of optimism" when talking about Spain and its potentialhttps://www.youtube.com/watch?v=XUFMxmIoFRc

3:25 am November 13, 2012

On the ground wrote:

I have not seen the EU calculations about the natural rate of unemployment in Spain, but I am very surprised by the level this article cites. Most economists have calculated that the natural rate of unemployment in Spain is around 12% or 13%. Anecdotal evidence about actually hiring/recruiting new employees would suggest that the level is far closer to 12% than 22%. The point the EU is probably making and I would agree with is that Spain had a couple of million people working in construction. Many of them will be forced back into agriculture and services. Others will go back to school. This is clearly a problem for Spain when compared to Greece. However, it would be an exaggeration to suggest that this problem leaves Spain in a worse overall position than Greece. I am sure most Greeks would be happy to swap their conditions for Spain's. Why doesn't the author ask himself the same question? I have no doubt he would choose to be in Spain if he is at all informed.

6:11 pm November 12, 2012

Tony wrote:

It is true that Spain is currently where Greece was 3 years ago. Spain having a more larger and productive economy than Greece is most likely to ride out the tide before the crashing of the wave much longer than Greece did due to this if it implements structural changes much faster. Yet it is true that Spain does have a high unemployment rate operating at potential capacity which is problematic and its real-estate sector is completely crashed with potentially more to follow. Greece on the other hand is and has for over a decade been operating below capacity and it has potential for growth. But the problem in Greece is that it has not done any structural changes since the 70's to realize this growth and encourage investment. Add its Byzantine laws and red-tape and a irresponsible government simply addicted to debt to solve short-term problems. Hence its low export volume in comparison to other EU members. Greece has many sectors of great growth if it actually smartened up. It's tourism, shipping, and high-quality agriculture have potential for great growth but they will need to bring in foreign direct investments for these sectors. Also it has not even taped it's resource potential and they are still to date relatively unexploited. Greece could do well for it's small population size if it was actually ran by competent politicians and not by bozos.

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The Wall Street Journal’s Brussels blog is produced by the Brussels bureau of The Wall Street Journal and Dow Jones Newswires. The bureau has been headed since 2009 by Stephen Fidler, who was previously a correspondent and editor for the Financial Times and Reuters. Also posting regularly: Matthew Dalton, Viktoria Dendrinou, Tom Fairless, Naftali Bendavid, Laurence Norman, Gabriele Steinhauser and Valentina Pop.